FEX - The Financial and Energy Exchange Group

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Welcome to The Financial and Energy Exchange Group

12 December 2008

The disturbances currently working through global financial systems give cause for market regulators, participants and observers to reflect. As a former large trader in many of the world’s most sophisticated financial markets, I would like to share some of my observations on the causes, effects and prospects for the conduct and development of financial markets.

Current market disturbances had their genesis in US and European property and credit markets. Compounded by ineffective/uncommitted risk management systems, this led to poor oversight of inherent credit risk, thus exacerbating systemic damage to international financial and real economies. Notably, within the Asian time-zone, 2 of the BRIC economic tigers and other great Asian nations have been caught in the contagion.

I share the view of others that, contributing to this and most other market disruptions, are failures in financial reporting standard application, inadequate circuit breakers and ineffective supervision and audit. Specifically, the oversight of individuals and groups within organisations and across organisations focusing on particular asset classes.

Over the coming months and years, there will be extensive debate on the optimal architecture for the global financial system. A wide and inclusive debate is all the more important as the management of global financial market systemic risk is an international challenge.

Through this evolving debate, many policy options will be considered. At the heart of this debate should be the core goal of enshrining the benefits of well functioning markets and market networks rather than dismantling current market structures.

Systemic market risk and contagion can be managed without compromising the inherent strength and flexibility of existing market structures. Well functioning markets provide a neutral venue for price discovery and formation which in turn provide price signals which drive efficient capital allocation.

Market reforms should be aimed at optimising the price discovery process through utilising levers that enhance transparency rather than constraining the flexibility current market structures offer.

The International Organisation of Securities Commissions (IOSCO) defines transparency as the degree to which information about trading (both for pre-trade and post-trade information) is made publicly available on a real-time basis. Transparency is the visibility into the general characteristics of market demand and price discovery.

When the history of this Financial Crises is recorded, underdeveloped market infrastructure will be highlighted. Sophisticated markets operate on three interdependent infrastructures – knowledge, technology and regulation. These three infrastructures together contribute to the price discovery process.

Exchange traded markets, through their business models and operations, provide a high order of pre- and post-trade transparency. Over the counter (OTC) markets have tended to be more opaque, especially in the area of pre-trade transparency. This does not make OTC markets by definition undesirable, nor does it mean that there are not opportunities to significantly improve certain dimensions of OTC market practice.

OTC market transparency and under-distributed central counterparty clearing will be counted amongst factors contributing to current financial market disturbances. The difference in the degrees of transparency within exchange traded and OTC markets is due both to both the nature of the products transacted and the business models of the brokers that service these markets.

The scale and importance of OTC markets in the world wide financial system should not be underestimated. Daily OTC market turnover is over AU$7.5 trillion and continues to grow. And whilst exchange traded markets provide standardisation and scale of participation, OTC markets provide product variety, innovation and flexibility. The depth and range of products transacted through OTC markets dwarf the range of products available through exchange traded markets. By their very nature, OTC specific product differentiators contradict efficient standardisation and commoditisation required for exchange traded environments.

Given recent failures within some OTC markets, arguments have been presented for regulatory fiat to migrate OTC market activity onto regulated exchanges. Forcing OTC activity onto exchange will lead to sub-optimal economic outcomes with ramifications extending beyond the underlying markets. Such moves, whilst commercially opportune for incumbent exchange operators and their shareholders, would significantly damage the price discovery infrastructure that facilitates the free flow of capital and the management of risk in less commoditised and standardised marketplaces.

Regulated exchange traded markets will continue to remain critical sources of liquidity to the world's capital markets and continue to provide transparent price discovery for much of the world economy's financial assets. However, exchanges are unlikely to be able to accommodate the product variety and flexibility available in OTC markets.

Exchange traded and OTC markets work symbiotically. Optimal outcomes are achieved when both markets are operating well.

OTC market improvement options have been posited by many commentators, including in the recent OTC Market white paper published by ICAP, the world’s largest interdealer broker. Improvement options include the wider adoption of electronic trading and trade confirmation systems for OTC market to operate in a fair, orderly, efficient and transparent manner.

Unfortunately, those who profit from market inefficiency will seek to obfuscate change. Similar to open outcry exchange traded markets five to ten years ago, voice-broked OTC markets are ripe for technological transformation. Such market transformation will not only improve transparency, but will also facilitate OTC central counterparty clearing.

As a business, FEX was designed to service both exchange traded and OTC market structures. This is based on our core philosophy of building a business to meet the needs of the market rather than trying to make the market fit our needs.

Our business is focused on the provision of markets and market infrastructure which deliver pre- and post- trade transparency in exchange traded (ETC) and OTC products. Through FEX-ETC and FEX-OTC, we offer our world class regulatory, technology and market structure competencies to the evolving Asian energy, commodity and environmental markets.

FEX is currently building its exchange traded infrastructure. Our core derivatives trading engine is being supplied by the world’s leading exchange technology group, NasdaqOMX.

We also support OTC markets through our Australian licensed and regulated marketplace which operates via our fully electronic and feature rich Mercari system. We seek to further enhance OTC market development to address potential areas of fragility through:

Continued development of our Mercari electronic solution with continued emphasis on auditability, straight through processing, accelerated settlement mechanisms and data storage; and

By actively supporting further infusion of Central clearing counterparties promoting standardisation of the mark-to-market and risk mitigation processes.

Our most recent market offerings include an environmental OTC market developed in partnership with Envex (a joint venture between FEX, Macquarie Capital Group and Climate Exchange plc). Through Envex, we seek to facilitate the promotion and development of carbon and environmental markets.

Our environmental OTC market opened in November 2008 with the first trade being an AU$230,000 parcel of Australian Renewable Energy Certificates (RECs).

On a personal note, I would like to take this opportunity to again express sincere thanks to our shareholders, employees and business partners for their ongoing support in our continued development. Their ongoing encouragement and support have been exceptional and very much appreciated. In particular NasdaqOMX has provided a world class service during the development phase of our exchange traded derivatives market.

Thankyou for visiting the FEX corporate site.

Brian Price
FEX Group CEO